Broker-Dealers vs. Registered Investment Advisers ('RIAs'): Which is Which?

The financial services industry is dense and complex, urging many of us to concentrate on only one or two sectors of its universe at a time. In the United States, securities may only be exchanged through a broker-dealer. A broker-dealer has accounts for customers (individuals, married couples, estates, businesses, etc.); for itself (known as proprietary trading or investment accounts); or for other broker-dealers. And these accounts primarily contain securities.

There are two overall types of trading – agency and principal.

In an agency trade, the customer orders a particular security transaction from the broker-dealer, which goes out to “The Street” (an old phrase used to represent another broker-dealer on Wall Street) from which it will purchase or sell the security to satisfy the order.

In a principal trade, the customer orders a security transaction which falls within the broker-dealer’s inventory or principal. The broker-dealer will either purchase or sell from its own inventory to directly satisfy the customer’s order.

When conducting agency trades, the firm acts as the Broker; while when transacting on the principal basis, the firm is the Dealer. Hence the name Broker-Dealer.

American investors often confuse Broker-Dealers with Investment Advisers. An Investment Adviser is often an SEC-registered (depending on size) financial services company. An Investment Adviser manages securities accounts for clients of all different denominations (like those of a broker-dealer), however these client accounts and their securities must be held at a Broker-Dealer.

In fact, the Investment Adviser acts as an intermediary between the Customer Account at the Broker-Dealer and the Client itself. The Investment Adviser usually has discretion over the Client Portfolio and purchases and sells securities through one or more broker-dealers to achieve the Client’s portfolio objectives.

Full discretion is when an Investment Adviser (usually an individual licensed with an NASAA Series 66) possesses the authority from the Client to transact securities for its portfolio (volume, price, time, etc.) at the Adviser’s will or discretion.

A key distinction between brokerage services provided by a Broker-Dealer and portfolio management services conducted by an Investment Adviser lies in the form of compensation for services. For transactions of exchange-traded securities, Broker-Dealers charge Commissions, Concessions, or MarkUp/Downs. Each of these charges (which will now be simply referred to as Commissions) are based on one individual transaction. The Commissions fall within a customer-provided Fee Schedule, and the Customer receives a trade confirmation for every transaction. If any deviation existed between the Fee Schedule and the actual Commission charged, that difference should be explained in the trade confirmation.

Investment Advisers charge their clients through Portfolio Management Fees (often called Investment Advisory Fees) which are calculated at an agreed-upon percentage with each individual client. These Advisory Fees are often billed quarterly and subtracted from the client’s account at that time. The Advisory Fees are assessed on the total portfolio value at each quarter-end. Some advisers deduct client cash balances from the total portfolio value used for assessment, while others use a reduced fee percentage for cash balances.

The number of SEC-registered Investment Advisers dwarfs that of Broker-Dealers. The reason for that may be because Broker-Dealers face heightened regulatory scrutiny, perhaps because the largest Broker-Dealers execute the actual securities transactions at the exchange level. While the large Investment Advisers are only governed by the SEC and their particular states in which they conduct business, Broker-Dealers are regulated by the SEC, the individual states, and FINRA (the “Financial Industry Regulatory Authority”).

In 2007 FINRA was born as a super Self Regulatory Organization (“SRO”) from the merger of the National Association of Securities Dealers (“NASD”) and the NYSE Member Regulation division. For decades previous the NASD had been maintaining all of the licensing information of the Broker-Dealers and the brokers themselves, called Registered Representatives. The NASD also had examiners and an examination cycle to inspect the conduct of the Broker-Dealers and their “Reps” pursuant to SEC rules.

So essentially FINRA was able to add expertise from the NYSE to administer an even more robust national compliance program, one which could even more deeply scrutinize overall Market Regulation in order to curb market manipulation and insider trading.

FINRA is the SRO responsible for regulating Broker-Dealers under SEC oversight. Nowadays, the SEC usually only directly examines Broker-Dealers and Registered Representatives if there is some cause, interest, repeatable and observable patterns of rule violations or customer harm, or overall market risk posed.

For example, if a Broker-Dealer is growing faster than seems legitimate or earning revenues that don’t seem realistic or fair to customers, the SEC may visit. Otherwise, the SEC defers to FINRA to regulate the universe of U.S. Broker-Dealers and the SEC has access to all of FINRA’s records. The SEC continually performs quality control reviews of FINRA’s examinations of Broker-Dealers and Reps to evaluate how well the securities rules are being enforced.

FINRA is the world in which Intersource Consulting Group LLC lives. My partner Donald R. Pollard and myself have a paramount objective of keeping FINRA happy on behalf of our Broker-Dealer clients. But before you can keep them happy, you have to know more about what FINRA is and what it isn’t. FINRA is not the government. FINRA is contracted by the SEC to oversee Broker-Dealer and Broker business activities in the U.S. and other parts of the world (mostly Canada) where securities business is being conducted by U.S. Registered Representatives.

FINRA is a company itself with a goal of being profitable. The annual assessment fees and fines paid by Broker-Dealers is the revenue of FINRA. FINRA’s regulators from different departments compete for various positions throughout the organization among its regional districts.

FINRA requires every Broker-Dealer to have a Chief Compliance Officer (“CCO”) and a Financial and Operations Principal (“FINOP”). The CCO must have the FINRA Series 24 Supervisory Principal license, however just having this license does not ensure that FINRA will approve that title. One must generally demonstrate a few years of experience with a Series 24 before becoming a CCO. The FINOP acts as the Chief Financial Officer of the Broker-Dealer and must hold the FINRA Series 27 license. FINRA issues all Broker-Dealer licenses, and administers all examinations and continuing education.

Don Pollard fulfills the CCO obligations for Intersource Consulting Group, and he serves as the CCO for a number of Broker-Dealer Clients. While many CCOs work for one Broker-Dealer and have one designated office location and one overall set of responsibilities, Don meets the Chief Compliance Officer needs for each of his various clients, traveling to each client when the needs demand.

Regardless of the particular client, while compliance needs do vary from firm to firm, a CCO needs to equip any Broker-Dealer with a current, reasonable, and representative set of Written Supervisory Procedures (“WSPs”), an Anti Money Laundering Compliance Program (“AMLCP”), and a Firm Element Training Program to continually educate the licensed personnel.

Just as important as the documentation just described, the CCO is ultimately responsible that all transactions conducted by the Broker-Dealer are compliant, and if he/she is not able to personally supervise every transaction, an effective supervisory system must be implemented by the CCO.

I meet the FINOP side of the compliance equation for Intersource’s Broker-Dealer Clients. The Securities and Exchange Act of 1934 calls for Broker-Dealers to maintain accurate financial statements and an adequate Net Capital balance, based upon the type of firm, business activities conducted, etc. Every quarter or month, based upon business activities, etc., a Broker-Dealer must submit a FOCUS Report, which is FINRA and the SEC’s copy of the unaudited financial statements and net capital computation for that period.

Every firm has a FINRA Coordinator who assesses the FOCUS Report, and often there can be questions, particularly if financial statement balances change, or are added or subtracted. The FINRA Coordinators seek to familiarize themselves with the balance sheet and income statement of their assigned Broker-Dealers, as these financial statements should tell the story to a firm’s business operations.

Don Pollard and I provide a CCO/FINOP Compliance Package to Broker-Dealers. By working together in these capacities, we are able to confront compliance challenges in a unified team approach, which becomes particularly invaluable during the FINRA Examinations, during which several Broker-Dealers, regardless of their compliance team, are completely overwhelmed. Additionally, because Don and I work remotely, we can perform the CCO/FINOP Principal functions for a fraction of the cost of having your own Principals work exclusively on-site with offices and all of the other full-time employment benefits.

If you’re a Broker-Dealer that has Compliance Needs (CCO, FINOP, Principal), give Intersource Consulting Group a call at (631)721-3541, (978)335-7015 or visit

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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